BIRMINGHAM, Alabama (Reuters) - From corrupt and incompetent local officials to Wall Street's credit crisis and toxic bonds, there was plenty of blame to go around on Thursday, a day after Alabama's Jefferson County declared the biggest municipal bankruptcy in U.S. history.
The county, once a leading industrial hub in the U.S. Deep South, filed for bankruptcy court protection after failing to reach final agreement on terms of a preliminary deal with creditors led by JPMorgan Chase & Co in September to settle $3.14 billion in sewer-system debt.
Federal Judge Thomas Bennett in Birmingham set a December 15 deadline on Thursday for a hearing on whether the county is eligible to file for Chapter 9, the section of the U.S. Bankruptcy Code that covers municipal bankruptcies.
The head of the Jefferson County Commission, which voted 4-1 for bankruptcy, pointed to a $140 million decline in the savings expected from the preliminary deal as the trigger for the filing.
"The terms were set, they were agreed upon, and the final agreement wasn't parallel with those terms," said David Carrington, the commission president.
Carrington also laid blame at the feet of Governor Robert Bentley and the state's Republican-controlled legislature for not calling a special session to raise taxes to help Jefferson County settle its debt.
For the roughly 660,000 residents of Jefferson County, which includes Birmingham, the state's largest city, bankruptcy means a threat to essential jobs and services. More immediately, it means sewer system rate hikes, an added burden on poor people already saddled with some of the highest rates in the country.
"It's terrible for the sewer rate payer," said John Young, a receiver appointed by the Jefferson County Circuit Court to manage the sewer system on behalf of creditors. He said double-digit rate increases were already planned.
Consequences of the filing include a likely increase in the county's cost to raise funds in the bond market, at least temporarily.
The impact of the bankruptcy was seen in the U.S. municipal market on Thursday. More than $1 million of the county's thinly traded sewer bonds due in August 2012 traded at 52 basis points over Municipal Market Data's triple-A scale as an investor required a higher yield, an MMD analyst said.
That was a big jump from the last time the issue traded on August 4 when a block of $3.5 million bonds changed hands at 7 basis points over MMD's triple-A scale.
"The name is getting people scared," said MMD analyst Domenic Vonella.
The debt crisis could also have a contagion effect on neighboring counties, while rattling the $3.7 trillion U.S. municipal debt market.
Jessie Morris, a notary public waiting in a long lime outside the Jefferson County courthouse in Birmingham on Thursday, said bankruptcy would likely exacerbate the impact of the economic downturn on cash-strapped county residents.
"It's been bad. You are trying to live from paycheck to paycheck and pay your bills. People have lost jobs. This is going to make it worse," she told Reuters.
"This is messed up," added longtime resident Angela Abreu, a translator standing on the same line. "It's sad. Birmingham is just getting pathetic."
Jefferson County's debt escalated in the mid-2000s when bond issuance deals to upgrade its sewer system soured amid widespread corruption, bribery and fraud charges that led to some 22 convictions.
Costs ballooned as interest rates rose, and the county had teetered on the edge of insolvency since its debt was downgraded in 2008. With more than $5 billion in total indebtedness, the Chapter 9 filing on Wednesday surpassed that filed by Orange County, California, in 1994.
Larry Langford, a Democrat and former mayor of Birmingham, was sentenced to 15 years in prison last year for his role in corrupt business deals that fueled the multibillion-dollar sewer debt. Langford presided over the county commission during the height of the bond swaps that led to the run-up of the massive debt.
JPMorgan, which has said it wanted to avoid bankruptcy, has already paid more than $75 million and waived about $647 million in fees as part of a settlement with the U.S. Securities and Exchange Commission over charges of fraud in connection with Jefferson County's sewer debt.
Carrington, who heads the five-member county commission, said Jefferson County was continuing to pursue claims against JPMorgan and some of its affiliates.
Other leading unsecured creditors of the county include Bayerische Landesbank in Munich. JPMorgan holds roughly $1.2 billion of the county's sewer debt, although it says the bankruptcy will have no material impact on its financial results.
According to Carrington, a leading reason for the collapse of the preliminary agreement was that the estimated savings from the deal had shrunk by about $140 million.
The savings was direly needed because, apart from its sewer bond debt, Jefferson County's general fund budget was slashed to $217 million this financial year from $312 million last year and there was a $40 million shortfall, Carrington said.
The county had also agreed to take $10 million out of its reserve fund -- pushing it to the limit.
"When the sewer agreement's new requirements were placed before us, as well as the general fund crisis it, became time to move on," Carrington said in reference to the bankruptcy decision.
In a court document supporting its claim for bankruptcy relief, Jefferson County said its sewer rates had already more than quadrupled over the last 15 years and said further steep rate hikes demanded by the court-appointed receiver would violate "reasonable" and "nondiscriminatory" provisions of Alabama law.
To subsidize the rate hikes from its own general funds, the filing also said the receiver, Young, had demanded that the county pay to him $75 million in general fund cash, the court filing said.
This was based "on the novel theory that he (Young) -- not the county -- was the rightful recipient of the $75 million received by the county from JPMorgan Securities," it said.
"The county therefore faced the intolerable circumstance of having an unelected third party attempt both to impose unreasonable sewer rate increases on the county's citizens and to seize the last monies in the county's general fund reserves, all for the benefit of the holders of the very indebtedness that has wreaked havoc on county's solvency and financial wherewithal," the filing said.
"The receiver's looming demand for the payment of $75 million from the county and the possibility that the receiver might succeed with his efforts to seize all the county's remaining restricted general funds rendered impracticable all further negotiations with the county's creditors," it said.
Some analysts have said the action should not be viewed as a harbinger of more bankruptcy filings in the municipal bond market.
Municipal bankruptcies remain rare. The crisis in Jefferson County is more about a revamp of a sewer system that went awry than something systemic to the municipal bond market, those same analysts argue.
What happens in Jefferson County, and in its federal bankruptcy court, however, could possibly set a precedent for other troubled municipalities after the recent high-profile debt crisis in Pennsylvania's capital of Harrisburg.
"I am extremely disappointed," said Young, who disputed Carrington's claim that creditors had changed the terms of the September deal.
"I was here to solve a problem and we had the problem solved," he said, as he laid the blame for the bankruptcy filing squarely on the shoulders of the county commission.
"Politics ruled, logic doesn't," he said.
(Writing by Tom Brown; additional reporting by Verna Gates in Birmingham and by Karen Pierog and Jim Christie; Editing by Kenneth Barry and Leslie Adler)